Why Restricted Stock Is Better Than Stock Options

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Many companies are concerned by the Financial Accounting Standards Board (FASB) recommendation that stock options be shown on the company's expense sheet. Especially high-tech and start-up companies are concerned because they fear losing one of their great recruiting and motivating tools. But there's no need to worry because there is already a better compensation choice, restricted stock options.

Motivation Through Restricted Stock

Issuing restricted stock is a better motivating tool than granting stock options for two reasons.

First, many employees don't understand stock options. They don't know that they have to take action in order to realize any gain. It is far easier for them to understand a vesting period on restricted stock. The second reason is that restricted stock can't become worthless like stock options. Even if the stock price falls, the restricted stock retains some intrinsic value.

The math is fairly simple. A stock option grant with a strike price of $10 has no value when the stock trades at $8. Restricted stock awarded when trading at $10 is still worth $8. Meanwhile, the stock option has lost 100% of its value while the restricted stock has only lost 20% of its value.

Employee Ownership Through Restricted Stock

One of the advantages restricted stock has from a management perspective is that as a motivating tool it allows employees to think, and act, like owners. When a restricted stock award vests, the employee who received the restricted stock automatically becomes an owner of the company.

The employee doesn't have to take any action to achieve ownership and is now entitled to vote at the annual meeting. Becoming a stakeholder also encourages employees to focus more on meeting corporate goals.

Stock options, on the other hand, do little to instill a sense of ownership and are usually viewed as a high-risk gamble that has a potentially great reward.

An employee may invest a couple of years helping a company grow and prosper and be compensated with stock options but their loyalty is to raise the stock price so they can cash out and make a bundle. These employees often choose actions that will raise stock price in the short term (to increase their potential gain) rather than taking the long view that ultimately helps the company grow and prosper over time.

Restricted Stock Supporters

The world's biggest online merchant, Amazon, knows how to sell to its employees, as well as to the general public.  Amazon.co.uk notes that all their employees are allocated a number of Amazon.com restricted stock units when they join. The Altria Group, Inc. also went that route when they announced they made equity awards in shares of restricted stock rather than fixed-price stock options. Dell Computer Corp., Cendant Corp., and DaimlerChrysler AG have also moved toward restricted stock in lieu of stock options.

Restricted Stock FAQ

If you have questions about restricted stock awards as a motivating form of compensation, see the Restricted Stock FAQ. There is a comparable FAQ about stock options here.